Unpacking the American Taxpayer Relief Act of 2012

In the early hours of 2013, Congress enacted the American Taxpayer Relief Act of 2012 (ATRA or the “Act”) in order to avoid the so-called “fiscal cliff.” We’ve extracted provisions from the 157-page Act that are of most relevance to churches and church employees.

The American Taxpayer Relief Act of 2012 has two major features—an increase in the tax rates paid by the wealthiest Americans, and an extension of several tax benefits that were scheduled to expire at the end of 2011 or 2012.

Some expiring tax benefits were not extended. Most notably, Congress chose not to extend the so-called payroll tax “holiday” that reduced the Social Security taxes for both employees and the self-employed for the past two years. This results in a tax increase for three out of every four Americans in 2013.

Expiration of the reduction in Social Security taxes. Prior to 2011, employees paid a 6.2 percent Social Security tax on all wages earned up to the annual “wage base” and self-employed individuals paid a 12.4 percent Social Security self-employment tax on all of their self-employment income up to the same threshold.

Congress enacted legislation in 2010 providing for a payroll tax and self-employment tax “holiday” during 2011 of two percentage points off the employee share of Social Security tax, and the Social Security component of self-employment taxes. This meant that the employee share of Social Security taxes dropped from 6.2 percent to 4.2 percent of wages, and the Social Security component of self-employment taxes dropped from 12.4 percent to 10.4 percent of self-employment earnings. This reduction in taxes was enacted to stimulate the economy by increasing the take-home pay of millions of workers.

Congress enacted legislation in 2012 temporarily extending the payroll tax cut for employees and self-employed persons through 2012.

The American Taxpayer Relief Act of 2012 does not extend the reduction in Social Security taxes after 2012. This has the following consequences:

Churches, like any employer, must take into account the elimination of the reduction in Social Security taxes when withholding Social Security taxes from nonminister employees.

Ministers are self-employed for Social Security, and pay the self-employment tax rather than Social Security and Medicare taxes. Their self-employment taxes will increase 2 percent beginning in 2013. To illustrate, a minister earning $50,000 in 2013 in the exercise of ministry will pay an additional $1,000 in self-employment taxes.

The housing allowance exclusion applies only to income taxes, and not self-employment taxes. As a result, the 2-percent hike in self-employment taxes will apply not only to a minister’s salary, but also to any church-designated housing allowance and the annual rental value of a church-provided parsonage.

Ministers should take into account the hike in self-employment taxes when computing their quarterly estimated tax payments for 2013 and future years.

Impact on charitable contributions. Some analysts predict charitable contributions will decline as a result of the American Taxpayer Relief Act, for three reasons:

First, charitable contributions are discretionary outlays and many high-income taxpayers may cut back on their contributions to offset the impact of higher taxes. According to the latest IRS statistics, higher-income taxpayers pay a larger percentage of their household income to charity than lower-income taxpayers. Will higher taxes cause the rich to cut back on their contributions? It’s too soon to tell, but the possibility exists.

Second, the reinstatement of the “Pease limitation” (addressed below), which caps charitable contributions for the wealthy at 20 percent of the amount of their contributions, may cause higher-income taxpayers to cut back on their giving. Note that the Pease limit impacts taxpayers at a lower level ($300,000 for joint filers) than the higher-income tax rates ($450,000 for joint filers), which may disincentivize charitable giving for a larger group of taxpayers.

Third, many taxpayers make some or all of their contributions by payroll deductions at work. Many of these taxpayers were stunned to see smaller paychecks in the early weeks of 2013 following the expiration of the 2-percent reduction in Social Security taxes that prevailed for the previous two years. Some undoubtedly will seek to offset the financial impact of higher Social Security withholdings by reducing or canceling contributions made by payroll deduction.

Permanently extend the 10 percent bracket. Under prior law, the 10 percent individual income tax bracket expired at the end of 2012. Upon expiration, the lowest tax rate would increase to 15 percent. The Act extends the 10 percent individual income tax bracket for taxable years beginning after December 31, 2012.

Permanently extend the 25 percent, 28 percent, and 33 percent income tax rates for certain taxpayers. Under prior law, the 25 percent, 28 percent, 33 percent, and 35 percent individual income tax brackets expired at the end of 2012. Upon expiration, the rates were to increase to 28 percent, 31 percent, 36 percent, and 39.6 percent respectively. The Act permanently extends the 25 percent, 28 percent, and 33 percent rates on income at or below $400,000 (individual filers), $425,000 (heads of households), and $450,000 (married filing jointly) for taxable years beginning after December 31, 2012, but lets the 35 percent rate for income above these amounts expire, which reinstates a tax rate of 39.6 percent for taxable income above these amounts.

Federal Income Tax Rates for 2013 Rate Single filers Joint returns

Note that the table reflects marginal tax rates (the tax rates that apply only to the corresponding income described in the table). For example, a married couple with taxable income of $100,000 will not pay the 25 percent rate on this entire amount. Rather, the first $17,850 of taxable income will be taxed at 10 percent, and income from $17,850 to $72,500 will be taxed at 15 percent. Only income from $72,500 to $100,000 will be taxed at 25 percent, meaning that the couple’s effective tax rate will be 16.9 percent. This rate will be even lower when deductions, credits, and exclusions are considered.

Permanently repeal the Personal Exemption Phaseout for certain taxpayers. In order to determine taxable income, an individual reduces adjusted gross income by any personal exemptions, deductions, and either the applicable standard deduction or itemized deductions. Personal exemptions generally are allowed for the taxpayer, his or her spouse, and any dependents. For 2012, the amount deductible for each personal exemption is $3,800. This amount is adjusted annually for inflation.

Prior to EGTRRA, the exemption was phased out as a result of the Personal Exemption Phaseout (“PEP”) for taxpayers with adjusted gross income (AGI) above a certain level.

EGTRRA repealed the PEP over five years, beginning in 2006. The phase-out was reduced by one-third in taxable years beginning in 2006 and 2007, and by two-thirds in taxable years beginning in 2008 and 2009. The repeal was fully effective for taxable years beginning in 2010. In explaining the reason for repealing the phase-out, a congressional conference committee noted that “the personal exemption phase-out is an unnecessarily complex way to impose income taxes and the hidden way in which the phase-out raises marginal tax rates undermines respect for the tax laws.”

The Tax Relief, Unemployment Insurance Reauthorization and Job Creation Act of 2010 (TRUIRJCA) extended the PEP repeal through 2012.

The American Taxpayer Relief Act of 2012 extends the PEP repeal on income at or below $250,000 (individual filers), $275,000 (heads of households), and $300,000 (married filing jointly) for taxable years beginning after December 31, 2012.

Permanently repeal the itemized deduction limitation for certain taxpayers. In his acceptance speech during the 1988 Republican National Convention, presidential candidate George H.W. Bush famously pledged, “Read my lips: no new taxes.” Two years later, as president, he reluctantly broke his promise and signed the Omnibus Budget Reconciliation Act of 1990. This Act raised taxes in a number of ways, including the so-called “Pease” limit on itemized deductions (named after Ohio congressman Don Pease, who first proposed it). This limit required certain itemized deductions, including charitable contributions, to be reduced by 3 percent of a taxpayer’s adjusted gross income over $100,000 (adjusted annually for inflation), but not by more than 80 percent.

In 2001, Congress enacted a law (EGTRRA) that phased out the Pease limit by one-third in 2006 and 2007, by two-thirds in 2008 and 2009, and by 100 percent in 2010. EGTRRA contained a “sunset” provision calling for this and many other provisions to expire at the end of 2010. This would have reinstated the Pease limit beginning in 2011. However, Congress enacted legislation in 2010 extending the elimination of the Pease limit through 2012.

The American Taxpayer Relief Act of 2012 permanently extends the repeal of the Pease limit on income at or below $250,000 (individual filers), $275,000 (heads of households), and $300,000 (married filing jointly) for taxable years beginning after December 31, 2012.

Permanently extend the 2001 modifications to the child tax credit. Generally, taxpayers with income below certain threshold amounts may claim the child tax credit to reduce federal income tax for each qualifying child under the age of 17. In 2001, EGTRRA increased the credit from $500 to $1,000 and expanded refundability. The amount that may be claimed as a refund was 15 percent of earnings above $10,000.

The American Taxpayer Relief Act of 2012 permanently extends these provisions for taxable years beginning after December 31, 2012.

Temporarily extend the 2009 modifications to the child tax credit. The American Recovery and Reinvestment Act of 2009 (ARRA) provided that earnings above $3,000 would count toward refundability. The bill extends the ARRA child tax credit expansion for five additional years, through 2017.

Permanently extend marriage penalty relief. In the past, when two persons were married, they often paid more taxes than if they had remained single. This discrepancy is known as the “marriage penalty.” This penalty arose in several contexts, including the following: (1) A married couple’s combined income often put them in a higher tax bracket than if they had remained single; (2) the standard deduction for a married couple was less than the standard deductions for two single persons; and (3) the earned income tax credit penalized married couples since their combined income placed them in or above the phaseout ranges for the credit. EGTRRA reduced the marriage penalty in the following ways: